The Remaking of Wall Street, 1967 to 1971

10/2/2000

An unprecedented surge in trading volume in the late 1960s overwhelmed Wall Street's brokerage firms, and what began as a paperwork snarl became a financial crisis that transformed the securities industry. In this excerpt from his article in the Business History Review, Auburn University's Wyatt Wells looks at the aftermath of a crisis that remade the Street.

by Wyatt Wells

Events in the late 1960s reshaped the securities industry. Trading volume increased sharply, with the number of shares changing hands on the New York Exchange growing from five million a day in 1965 to twelve million a day in 1968.

As Wyatt Wells describes in Business History Review, this expansion overwhelmed the mechanisms brokers used to transfer securities and keep records, which relied heavily on paper and pen. They responded by purchasing computers, but these machines were expensive and demanded more sophisticated management than most firms could provide. Accordingly, many companies botched the process.

Moreover, trading volume declined sharply in 1969 and 1970, cutting deeply into brokerage revenue. These factors combined to create a crisis that had, by the end of 1970, forced nearly a sixth of the nation's brokerage firms out of business.

In this excerpt from his article, Wells describes the immediate aftermath of the crisis and the changes in the securities industry that occurred in its wake.

Conclusions: Wall Street Remade
In early 1971, an uneasy calm settled over Wall Street. For the first time in over a year, no major brokerage house seemed in danger of collapse, and transactions were going through without too much trouble. Was this merely a lull, or had the storm passed?

Wall Street soon answered the question. As the economy bottomed out in the summer of 1970, the stock market surged forward and trading increased substantially. This naturally raised fears of a new record-keeping crisis. In September 1970, a Wall Street Journal headline proclaimed, "Back-Office Problems at Brokerage Houses Likely to Recur Soon." 143 By early 1971, volume on the New York Exchange was running ahead of 1968, and fails had increased substantially over late 1970, although they remained well below the 1968 level. The real test, however, came in late February when, because of the Lincoln's birthday holiday, securities markets had to settle two days' worth of trades simultaneously. The industry braced for the worst, yet as the Wall Street Journal put it, "Everyone expected a crisis yesterday, but it didn't occur."144 In March, the heaviest trading month thus far in NYSE history, fails actually declined slightly.145 The situation was still far from perfect, but it was clear that the securities industry had decisively brought its paperwork under control.

The crisis had exacted a terrible toll, however. In 1969 and 1970, over 100 member firms of the New York Stock Exchange, one sixth of the total, disappeared as a result of either mergers or liquidations. An undetermined but substantial number of firms outside the Exchange folded as well. Thousands working in the securities industry lost their jobs, careers, and fortunes in the conflagration. The stock market had seen nothing even remotely comparable since the Great Depression. Robert Haack did not exaggerate when, in early 1971, he wrote to the NYSE membership of "the trauma . . . to which every one of us has been subject during the period of crisis."146

The paperwork crisis was the chief culprit. The 1967-68 boom in business, coupled with the 1969-70 bust would have created trouble in the best of circumstances. The back-office problems turned the situation into a disaster, however, by depriving many firms of control over their records and costs. Almost every firm that went under suffered greatly from confusion in its back office. Robert Haack estimated that record-keeping problems accounted for 90 percent of the money spent by the NYSE to liquidate the ten firms that had failed by mid-1970, and chaos in their back offices precipitated the collapse of Hayden, Stone, Goodbody, and Dupont.147

Some observers extracted a moral from these events, blaming the crisis on Wall Street's ethical decay. Brokers were sloppy with their business and careless about the welfare of their clients.148 The truth was less exciting but perhaps more profound. Wall Street was neither more nor less virtuous in the late 1960s than at any other time over the previous two decades. Most brokers operated in ways that had served them, their customers, and the country well enough for generations. However, the explosion of business after 1965 changed the nature of the securities industry, and many of those in it did not react fast enough.

Growing volume altered the cost structure of the business. Only computers could handle the new level of transactions, but they were expensive. Some firms simply could not afford the machines. As one study noted, "The investment required of small firms to automate is prohibitive."149 Perhaps just as important, computers created economies of scale. As a senior partner of one major firm noted, "None of these steps [computerization] reduced overhead. However, they did enormously increase ability to process and handle business."150 In other words, computers cost the same whether busy or idle, so that the more transactions a firm processed, the lower its cost per transaction. This had not been the case with clerks.

Automation encouraged diversification. The brokerage business was quite volatile, and a computer system geared to handle heavy trading would have idle capacity in calmer times. This gave firms a strong incentive to develop new lines of business that could provide a more steady flow of transactions. Cultivating new sources of revenue was not easy, however. An auditor's report on Goodbody & Co., which during its last few months tried to diversify into underwriting and managing money for institutions, commended the effort but noted, "The successful development of any or all of these services requires considerable lead time and dollar investment."151

Automation and diversification demanded sophisticated management. A conscientious businessman could run a small brokerage effectively without cost accounting or management charts, but a firm with dozens of branches and active in several lines of business required more. Unfortunately, few brokerages had leadership equal to the challenge. Few on Wall Street devoted themselves to administration, and fewer still developed the sort of procedures necessary to guide really large organizations. As a result, even firms like Hayden, Stone, Goodbody, and Dupont, which had the resources to prosper in the new era, collapsed because their management failed to adapt. Without able leadership, size merely provided the opportunity for large mistakes.

The events of the late 1960s put the securities industry on a treadmill. To cope with rising volume, brokerage firms needed computers and professional management, which required substantial capital. Although brokerages needed a steady stream of transactions to pay for this investment, stock-market volume remained volatile. Fortunately, sophisticated computer and administrative systems allowed brokers to handle not only more business but also more types of business, permitting diversification. Firms that had specialized in brokerage moved into underwriting, while those that had concentrated on underwriting expanded into brokerage. Companies that had confined themselves to stocks and bonds started trading commodities, currencies, and options. Brokers that had emphasized selling to institutions started managing money for individuals, while those that had dealt chiefly with individual investors sought out institutional customers. Firms often developed entirely new lines of business, creating money-market funds and managing Individual Retirement Accounts (IRAs) and 401(k) retirement plans. Yet each expansion required further, heavy investment in automation and management as well as large infusions of capital, which in turn sent firms in search of even more business. To meet these demands, brokers merged and sold stock in themselves to the public. By the end of the century, publicly owned behemoths like Merrill Lynch, Goldman Sachs, and Morgan Stanley Dean Witter dominated the securities industry, operating on a scale that dwarfed even the largest firms of the late 1960s. Meanwhile, the proliferation of financial services fueled the explosion of volume in securities markets, which, by the late 1990s, totaled fifty or one hundred times that of thirty years earlier.

Of course, in 1971 no one knew what the future held. Nevertheless, it was already clear that the paperwork crisis had changed the securities industry. It had hastened concentration among stockbrokers. Between 1968 and 1970, the number of NYSE members doing $20 million or more in commission business dropped from thirty-eight to twenty-four, largely because of mergers and liquidations.152 The industry had also taken its first tentative steps toward allowing public ownership of brokerage firms.153 Finally, there was a new emphasis on management. As Robert Haack wrote in 1971, "The day of the casually managed brokerage firm is over. A tolerant and uninformed attitude toward inefficiency has no place in a securities business that has survived the recent flood and drought that followed in its wake."154

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Excerpted from the article "Certificates and Computers: The Remaking of Wall Street, 1967 to 1971" in Business History Review, Summer 2000.

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Wyatt Wells is associate professor of history at Auburn University, Montgomery.

143Wall Street Journal, 11 Sept. 1970, 1.

144Ibid., 23 Feb. 1971, 7.

145Ibid., 16 April 1971, 2.

146NYSE, "Annual Report, 1971," 2, NYSE Archives.

147SEC, Unsafe and Unsound Practices, 98.

148See Christopher Elias, Fleecing the Lambs (Chicago, 1971) and Hurd Baruch, Wall Street: Security Risk (Washington, 1971). Even Brooks's The Go-Go Years, a generally good history of Wall Street during the 1960s, offers a strange moral judgement on the back-office crisis, coupling discussion of the subject with an examination of increasing drug use by the staff of brokerage firms (chap. 8).